Wednesday, December 17, 2014

What dividend stocks would I buy if I were just starting out as an income investor?

I have been investing in dividend growth stocks and discussing dividend growth stocks on this site since early 2008. I have learned that dividend investors need to be flexible, and constantly be on the lookout for attractive investments.

This is because companies from different sectors are attractive at different times. In addition, there are many companies within a sector that could have strikingly different fundamentals and valuations. It is very rare that the whole market and all sectors are cheap at the same time, like they were in 2008 – 2009. For someone who invests a little every month however, I need to find cheap stocks with attractive economics and good prospects all the time. I do not believe in keeping too much cash in my brokerage account, and waiting for the perfect opportunity that might or might not materialize. I would much rather have the capital work for me and start its compounding process right away.

I usually start with a list of dividend growth stocks like the dividend champions, and then narrow down based on my entry criteria. I usually notice that many of the most attractive companies are from a single sector or sectors. I then look at each company that meet my entry screen, and delve further into trends in revenue, expense, earnings, returns and dividends over the preceding decade. I also read annual reports and analyst reports to gain an understanding of the company and its inner workings.

The typical dividend stocks I purchased since 2008 included the likes of Colgate-Palmolive (CL and Kimberly Clark (KMB) up until 2012. Over the past two years however, I have been hard pressed to find good ideas among the typical suspects of the preceding 5 years. As a result, I have been looking for other income investments.

Right now, the best values I could find are in Energy sector. As I mentioned before however, I want to be diversified across time, industries, and not pile everything at once in one sector or company. Safety of capital is important to me. I also find a few consumer staples that are cheap, although not as many as in 2012. I also identified a few other good stocks, with favorable business prospects from other sectors below:

That being said, I am not envious of the investor who starts their dividend investing journey today. It is much more challenging to find quality companies selling at attractive valuations today, than it was 7 years ago. If someone were putting a set amount of cash to work every single month for several years however, the math should work well in their favor due to the fact that intrinsic valuations rise over time as companies earn more and thus pay more dividends. The power of dividends to grow over time, and for those dividends to be reinvested into more dividend producing investments should not be underestimated. In addition, if we get the bear market in stocks that everyone has been waiting for, the beginner investor would be able to deploy their cash at much better entry prices.

However, if the investor has a lump-sum to invest, the best idea might be to spread purchases over the next 12 - 24 months, especially if they are relatively new to the world of dividend investing. The importance of quality in selecting investments and the need for continuous education cannot be underestimated. To me, a quality company is the one which manages to have recurring revenues and earnings, which tend to increase over time and do that without much lumpy-ness. To achieve that, a company needs to have strong competitive advantages such as strong brands, advantages of scale or location, being a cost leader, and/or selling a unique product that commands pricing power. Check this article on wide-moat companies for more information.

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Questions or Comments? You can contact me at dividendgrowthinvestor at gmail dot com.